Income through 1099 vs. Corporation

[VG]

Hi everyone,

I posted this in the Beating the $51k Limit article, then realized it would be easier to get a response here.  Thanks for your input.

I have a 401k/profit-sharing plan in my main job, expected to max out this year. We have a C corporation.

I get separate money from the hospital that I can choose to run through the C corp (that then pays taxes), or I can receive it via 1099, put it on my schedule C, and then shelter some of it through a SEP-IRA.

My practice manager and CPA seem to disagree about whether it’s worth running income through the C corp for those taxes, or if it’s better to take it as a 1099. I figure with the marginal tax rate I’m in, I want to shelter as much income as possible.  The CPA says the tax that the C corp pays should only be around 1.4% (Medicare tax), because we would already have maxed all the state disability and social security taxes, so you’re better off getting a 1099 and putting as much into the retirement account as possible.  My partners and the practice manager say the taxes covered by the corp are closer to 5-6%.

Lastly, I read from WCI replies in the Beating the $51k Limit thread that having a SEP-IRA screws up the backdoor Roth conversion, but I don’t follow why. Wouldn’t you have two different IRAs? One you put your 5500 into and convert to Roth, and the other is the SEP-IRA to shelter the Schedule C income?  Regardless, is it better to have a solo 401k for the schedule C income?  I believe I have already maxed the employee contribution (18k) to the profit sharing plan from my main job, so I thought the SEP-IRA would be the better choice.

Thanks again!

[childay]

I am sure someone else more familiar with C corp taxes will weigh in but you could set up a solo 401k instead of the SEP-IRA and you would be able to contribute 25% of pay as an employer contribution (since you used your 18k already).

[VG]

Ironically, our profit sharing plan rep came by the office today.  He said it would have to be a SEP-IRA because we've already maxed out the 53k contribution to our 401k, and the IRS limit to all 401ks is 53k.  That limit does not apply to the SEP-IRA (which is WCI's point in the Beating the Limit article, I believe).

He could not speak to the tax questions of running income through our C corp vs. 1099 to maximize the SEP-IRA of course.

[litovskyassetmanagement]

The first thing is to make sure that you don't have a controlled group.  If you own more than 80% of the practice that has non-spouse employees, you wouldn't be able to have a separate solo 401k.  If you don't have a controlled group, you can indeed have a solo 401k and contribute ~20% of your 1099 income.  I'm not sure why you'd want a C corp vs. S-corp (if your hospital income is huge, then giving yourself a W2 and a distribution might save you ~3% on payroll taxes).  In that case you can contribute 25% of your W2.  Also, if you are old enough (ideally 35+) you can also potentially have a defined benefit plan to which you can contribute a significant amount that increases with age (starting about about $50k at age 35) on top of what you can contribute to a solo 401k plan.  So you have many options available to you depending on your age and the amount of your 1099 income.  Whether you get a 1099 or do an S-corp can also be influenced by whether you want a DB plan or not - having a W2 is much better from DB plan standpoint.

Here's more information on plans for solo contractors and self-employed:

http://quantiamd.com/player/ygvmhdmbm?cid=1467

You absolutely do not want a SEP.  Not only would that wreck your ability to do backdoor Roth IRA, but it won't work with a DB plan.  Also, you can do what's know as  'in plan Roth conversion'.  So when you have a huge tax-deferral (in the case of two 401k plans and a DB plan) you can also convert part of your 401k balance to Roth in excess of what's available with backdoor Roth.  Lots of tools to work with.

[jfoxcpacfp]

1. You asked why a SEP "screws up" the ability to do a backdoor Roth. The reason is that a SEP is a kind of IRA which is considered a "personal" retirement account, even though it is run through a business. It is considered an IRA, and therefore personal, because participants are immediately vested in their contributions, which is put in separately-owned accounts (kind of like a SIMPLE plan). Any personal, pre-tax retirement accounts (IRAs, iow) you own will cause you to pay taxes on backdoor Roth contributions.


2. Since you talk about "we" (owners, I presume) I will guess you do not own 80% or more of the C-corp. If so, you can set up a separate SOLO-401k, just as easy to set up and manage as a SEP, and contribute up to $53k ($59k if you are age 50+), but only as a % of income. (Plan reps rarely know anything about the rules and limitations of anything besides the plans they are trained to represent.)


3. Sorry you have a C-corp. I can't figure out why you would want to run personal income through a C-corp shared by other owners, especially since it will cut into others' profits, especially when you could have a schedule C business with the opportunity for some tax deductions and a new retirement account.

 

 

[childay]

It sounds like your rep doesn't know the rules for multiple 401ks

 

https://www.whitecoatinvestor.com/multiple-401k-rules/

 

 

[VG]

Okay, I've read through all the posts and I read the multiple 401k rules article, which I know understand better thanks to your responses.  Thank you!

 

My main job is a private practice.  I'm currently not a partner, but will be in one year.  I'm eligible for the profit sharing plan now, in my 2nd year of employment.  There are 3 current partners.  So there's no issue with > 80% of a controlling interest.  I make > 300k through the main job and can therefore maximize the profit sharing contribution of 53k.

The second job is income from the hospital.  It can be sent through my C corporation and "passed through" to me, or I can take it as 1099.  I also read some imaging studies at a separate facility that I will get 1099'd for.  Total opportunity for 1099 income this year is about $20k, but can go up to 30-40k in 2017, so I'm try to sort out all the retirement stuff now, and whether or not I should take as much 1099 income as possible.

I can't answer why my current main employer is a C corp.  None of my partners know anything about it.  None of them were part of the group when it was created as a C corp.  They don't know anything about C vs. S corps.

Thank you for clarifying the SEP-IRA.  I'll look into a Solo-401k instead.

 

[Crazyroadtodublin]

I have looked at this issue for hours and still can't seem to figure out what the answer is.  For me, after having a defined benefit plan for several years I shut it down because of the fees and went back to having a SEP.  I will give up the opportunity  of a Backdoor Roth and just do a straight conversion from my SEP to Roth when I retire early (making sure that I stay in low taxation levels.)  For me the fees of these plans seemed difficult to justify given the uncertainty of future tax rates.  Am I crazy????

[litovskyassetmanagement]

Crazyroadtodublin wrote:

I have looked at this issue for hours and still can’t seem to figure out what the answer is.  For me, after having a defined benefit plan for several years I shut it down because of the fees and went back to having a SEP.  I will give up the opportunity  of a Backdoor Roth and just do a straight conversion from my SEP to Roth when I retire early (making sure that I stay in low taxation levels.)  For me the fees of these plans seemed difficult to justify given the uncertainty of future tax rates.  Am I crazy????

Click to expand...

The benefit of the tax deduction can be huge.  Also, even if you are in the same tax bracket in retirement (a tall order), your tax RATE would be lower.  Your contributions are made from your highest brackets while your distributions are taxed at an average rate.  Also, there are ways to reduce taxes in retirement via Roth conversions.  Also a SEP and a DB plan are nowhere near comparable.  Usually the DB plan works together with a 401k plan, and admin fees for a solo 401k/DB combo plan are on the order of $2k a year or so, so I'm not sure what you mean by fees.  If you also want investment management, it can be done for a flat/fixed fee that's tax deductible, so no need to pay any asset based fees.  Also, this can allow you to do massive Roth conversions as you would be deferring significant amounts so you can also convert more of your retirement plan assets to Roth.  Basically, you'll need to do a cost benefit analysis to figure out which plan(s) would work best for you.

[Crazyroadtodublin]

Kon,

I appreciate your response.  I agree about the fees about 4 grand per year (2 for the 401k, 2 for the DB) to save an extra 50 grand over what I could do in the SEP.  The real unknown is will the rates be the same higher or even lower when I retire. ??? No one knows.

[litovskyassetmanagement]

Nobody knows those rates, that's true.  But in retirement your income falls to zero, so there are a number of things you can do to keep your tax rate low.  Also, that's why you want to diversify your future tax liability by using various buckets, including Roth and after-tax. I also mentioned that you can convert your tax-deferred savings into Roth prior to the RMD, and this can also save you significant taxes by minimizing RMD, so that's another great tool that's available.  For that you'll need to have a decent size after-tax portfolio.

If you are in the 40% federal bracket, chances are that your tax rate in retirement will be significantly lower.  And I just don't see taxes going up significantly in the future given the situation we are in.  Those states hiking taxes are seeing people leave.  Countries hiking takes also see people leave.  Countries with high taxes are not going to be viable long term.

One thing is true though - you can't plan for the doomsday scenario by pretending that it is as likely as all of the other scenarios.  Yes, maybe there is a 1% chance that taxes would be 100% in the future.  But you can't build a plan around it.  Chances are things would be much more mundane in 99% of the cases, and that's what the plan should cover.  For the other 1% of scenarios you'll need a lot more than money, and I usually don't go there because at that point money would be worthless.